EBF 483
Introduction to Electricity Markets

7.3 The California PX and ISO

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California's spot market for electricity also had a number of features that contributed to the electricity crisis. The designers of the electricity market were highly influenced by the design of futures markets for natural gas and crude oil, in which there was one market for the commodity sold at a specific geographic location (Henry Hub for the NYMEX natural gas or Cushing for the crude oil contract) and then transportation for the commodity from the market point was arranged separately. The spot market for electricity in California consisted of a single market run by the California Power Exchange (PX). The PX took supply offers and demand bids every hour, and cleared the market in an auction based on those bids and offers. The figure below shows the bids, offers and market clearing for an actual market hour from the PX. Note that the PX market had a price cap of $250 per MWh so no one was allowed to submit an offer higher than that number (although some tried, as you can see).

Graph showing a demand curve crossing a supply curve at 32,500 megawatts and $190.
Figure 7.5: Supply and Demand curves for the California Power Exchang September 3, 1998.
Surce: California Power Exchange (circa 1998)

In the example in the figure above, the clearing price would have been $190 per MWh and the clearing quantity would have been 32,500 MWh. Any generator who offered less than or equal to $190/MWh would clear the market and could be dispatched to produce electricity. Generators offering more than $190/MWh would not be cleared through the PX market. Importantly, all generators cleared in the PX market would get paid the market-clearing price of $190/MWh. This meant that generators with marginal costs less than $190/MWh would earn some profit. For example, a 100 MW generator with a marginal cost of $50/MWh clearing the PX auction would earn 100*($190 - $50) = $1,400 in profit for that hour.

Submitting generation offers into the PX market was subject to very few restrictions. Individual generators could decide whether they wanted to submit an offer at all in a given hour, and at the time there were no rules on the prices that were allowed and not allowed (beyond the $250/MWh price cap).

Once the PX market cleared for a given hour, those generators clearing the market were dispatched to produce electricity by the California ISO (Cal ISO). The Cal ISO would ask each generator where in the state it intended to deliver the electricity it produced. There were three delivery zones in the state as shown in the figure below: Northern California (NP15), Southern California (SP15) and Central California (ZP26).

California map showing three delivery zones: Northern CA, Central CA, and Southern CA.
Figure 7.6: Three California Power Exchange delivery zones.
Source: California Power Exchange (circa 1998)

If too many generators in the state wanted to deliver electricity to a specific location, or if the demand in a certain location was larger than the number of power plants that were cleared to deliver electricity to that location, then the Cal ISO would solicit what it called "adjustment bids" from all generators. These adjustment bids, which were also known as "incrementents (inc's)" and "decrements (dec's)" specified the amount of extra money that a generator would need to be paid in order to shift delivery to a different location, increase delivery to a location that was short of electricity, or de-congest a transmission line by producing less electricity. These adjustment bid prices would be added to the PX price for each zone, meaning that delivered electricity prices in each zone could differ.

Here's a simple example of how this might work in practice. Two generators clear the PX market, and the clearing price is $50/MWh. One is located in the NP15 Zone and one is located in the ZP26 zone. A third generator, located in the SP15 zone, submits an offer of $70/MWh and does not clear the market.

The Cal ISO realizes that all generators want to deliver to the SP15 zone, but the transmission line into the SP15 zone is congested. So the Cal ISO asks all three generators for adjustment bids. The generator located in the NP15 zone offers to redirect its electricity to NP15 if it is paid $20/MWh extra. The generator located in ZP26 offers to reduce output if it is paid $30/MWh extra. The generator inside SP15 offers to produce electricity inside SP15 at $70/MWh. This would yield the following zonal prices:

  • $50/MWh + $20/MWh = $70/MWh in NP15
  • $50/MWh + $30/MWh = $80/MWh in ZP26
  • $50/MWh + $70/MWh = $120 in SP15

In the end, generators are paid the zonal prices and customers in each zone pay those zonal prices.

This system strikes many students as odd. Indeed, it is. Below are some "frequently asked question" about the electricity pricing system used in California.

  • Question #1:
    Why does a power plant demand an extra $30 for each MWh not produced? Isn't this like paying farmers not to grow corn?
    • Answer #1:
      The $30 could represent almost anything. Some generators might face an engineering or opportunity cost from reducing output only for a particular hour. Others might charge more to produce less because they believed they could get away with it
  • Question #2:
    Doesn't the Cal-ISO collect more revenue from SP15 than it pays to the other generators?
    • Answer #2:
      Yes. This is called congestion revenue or congestion rent.
  • Question #3:
    Who gets this congestion rent?
    • Answer #3:
      In California it generally went to the owners of congested transmission lines.
  • Question #4:
    Isn't the scheduled delivery just a fiction, since actual flows are determined by Kirchhoff's Laws and Ohm's Laws?
    • Answer #4:
      Yes. The whole idea of a generator stating that their power would be delivered to a specific location is basically nonsense. But the Cal ISO had to treat this as if it was a physical fact.
  • Question #5:
    Is manipulating this system easier than getting your name in the phone book?
    • Answer #5:
      Yes. In the next part of the lesson we'll find out how.